Now that the shrinking of the Fed's balance sheet has been announced, I thought it worth nothing what it means for the future path of the monetary base. Drawing upon the Fed's median forecast of its assets through 2025 that comes from the 2016 SOMA Annual Report, I was able to create the figures below.
The figures show the trend growth path of currency and a series I call the 'permanent monetary base' extrapolated to 2025. The latter series is the monetary base minus excess reserves. This measure has been used by Tatom (2014) and Belongia and Ireland (2017) as a more reliable indicator of the monetary base that actually matters for monetary conditions. These two measures, which reflect the liability side of the Fed's balance sheet, are plotted along side the projected path of the asset side of the Fed's balance sheet. The first figure below shows this exercise in terms of dollars and the latter one is in log-levels.
What is interesting is that the Fed's median forecast of its assets eventually converges with the trend growth of currency which historically has made up most of the monetary base. Unsurprisingly, the permanent measure of the monetary base also tracks currency's trend path. Jim Hamilton does something similar here.
So what are the takeaways? First, the Fed is expecting to confirm the temporary nature of the monetary expansion under the QE programs. That is, the only major growth in the monetary base the Fed expects to persist is that coming from the normal currency demand growth that follows the growth of the economy. This endogenous money growth would have happened in the absence of QE.
Second, the temporary nature of the QE programs, implied by these figures, is a key reason why these programs did not spur a robust recovery. For reasons laid out in this blog post and in this forthcoming article, there needed to be some exogenous permanent increase in the monetary base to spur robust aggregate demand growth. It never happened and neither did the much-needed recovery. Instead we got the monetary regime change we never asked for.